BT Group is taking a write-down of Â£340 million in the third quarter to cover a shortfall in earnings on some of its 17 largest Global Services' contracts. It is still reviewing two of the 17 contracts, one of which is thought to be BT's London National Health Service (NHS) local service provider (LSP) contract, which could reportedly also incur a write-down in the hundreds of millions of pounds. CEO Ian Livingston has said he already expects a further "substantial" charge relating to the restructuring of Global Services and other cost-reduction measures.
BT has admitted that a handful of these contracts are unprofitable. Cost is always a major factor in government procurements (where BT has some of its largest deals, such as at the NHS and in local government), so this is little surprise. It is possible that BT has been overly aggressive on price and while this isn't a strategy peculiar to BT, it does expose its failure to turn around underperforming contracts.
Problem contracts need to be resolved fast
BT has undertaken a review of Global Services and its 17 largest contracts and, according to Livingston, found that it needs to take "a more cautious view of the delivery of cost efficiencies and contract performance, particularly in the light of the current economic climate." Global Services hasn't delivered enough cost savings, and in the all-important UK market, higher margin business is declining.
There has been lots of speculation over which BT contracts are underperforming. The 17 biggest deals on BT's books include programmes with Reuters, Unilever, Royal Mail, Barclays, Abbey, Bradford & Bingley and Lloyds TSB, as well as numerous public sector deals including the Department for Work and Pensions, HM Revenue and Customs, and several local government deals including Suffolk, Liverpool and Sandwell councils.
There are also three notable NHS contracts that BT is involved in for the National Programme for IT (NPfIT), which together account for over Â£2 billion in potential revenues. Within these 17 deals, BT has a high exposure to financial services clients and to the UK public sector. Both of these sectors are under huge pressure to cut costs as a result of the economic downturn.
The NPfIT continues to suffer from delays and an increasingly uncertain future. One of BT's NPfIT contracts in particular - the Â£996 million LSP contract to provide services to London's hospitals - is known to be in difficulty.
The contract was already some two years behind schedule when problems with the deployment of Cerner's software to the Royal Free Hospital in London hit the headlines last June, causing the suppliers and the organisation managing the programme NHS Connecting for Health (NHS CFH) to put a recovery plan in place.
Until the problems at the Royal Free Hospital are fixed, NHS CFH is unlikely to make any further commitments to BT. In the meantime, BT is entrenched in renegotiations with the NHS to make the terms of the deals less onerous. Unless BT and NHS CFH can resolve these issues quickly, we could see BT follow in the footsteps of fellow local service providers Fujitsu and Accenture, which have already left the programme. Such a development would call into question the future of NPfIT itself.
Review will be painful
There is no quick fix for Global Service's problems and the process of reorganisation is likely to be painful. Only recently, in November, the company cut 10,000 staff as part of a streamlining initiative focused principally on contractors, agency support and offshore staff.
This time around there needs to be a more root-and-branch appraisal, given the depths of the problems it has uncovered with some of its biggest contracts. Livingston needs to take a firm hand with these contracts, and consider whether it is in BT and its shareholders' best interests to continue serving loss-making deals.
This is going to be a difficult call, since it is winning deals such as these that has helped BT to shake off its old image and emerge as a network-led services provider. Backtracking on its network IT services ambitions would be a disappointing retrenchment from a market it has been seeking to dominate for several years.
No doubt more detail will emerge with its third-quarter results on 12 February to help clarify some of the burning questions that these admissions raise.